Those were the dark days that turned out to be the absolute bottom for the biggest market crash in 75 years.

Do you know what else it was? The best time to invest in a generation.

There has been a similar collapse in Canadian Resources stocks over the past couple of years. I’m not even sure what has caused it, but capital has been sucked out of this area of the market.

The chart below represents the TSX Venture Exchange. This entire index of stocks has dropped 60% over the last 30 months.

To look at it another way, this entire index needs to increase 250% just to get back to where it was in early 2011.

It is at the bottom of a crash like this that investors should be hunting for value. This is where good companies with solid balance sheets are available for bargain bin prices.

I think that Aroway Energy (TSX:ARW)(OTC:ARWJF) might be one such bargain that investors should consider.

Aroway Energy – The Properties

Aroway has four small properties in the Western Canadian provinces of Alberta and Saskatchewan.

As a small producer with limited access to capital, Aroway has chosen not to chase horizontal oil and gas plays which have big drilling costs and steep initial declines.

Instead, Aroway has focused on conventional oil properties with manageable well costs and lower decline curves. These are the types of assets that a small producer should be focused on.

Property 1 – West Hazel Saskatchewan (100% Operated)

The West Hazel Property was acquired in November 2012 and is an oil producing property in Western Saskatchewan.

At the time of purchase the property was producing 265 barrels of oil per day.

Aroway is currently in the process of drilling a water disposal well and building a facility at West Hazel. This will not just serve to reduce operating costs ($150,000 of water trucking costs will be gone completely), but also significantly extend the property’s reserve life.

Additionally there are two currently shut in wells that can be restarted with better water handling capabilities.

To pay for the cost of the water disposal well, Aroway struck a deal with two private companies which will see the cost of the $1.4 million water disposal well and facility paid for out of the reduced operating costs.

The two restarted wells and the new well along with the existing producers and reduced operating costs will basically cover this cost in about a year or less.

Once the disposal well is complete, production at West Hazel should increase from 240 barrels per day to up to 400 barrels per day.

Aroway then plans to drill two development wells in 2014 each of which would be expected to come on production at about 80 barrels per day and have netbacks of just under $40.

Property 2 – Kirkpatrick Lake (100% Operated)

The Kirkpatrick Lake property was also purchased in 2012. When purchased this was not a producing property.

Aroway has since drilled two successful wells on the property. The second well was completed in December 2013 and is currently producing at a restricted rate of approximately 100 barrels per day. Total production at Kirkpatrick is 300 barrels per day as the first well continues to produce at about 200 boe/day.

Operating costs on the property are very low, and the company is realizing netbacks of over $65 per barrel at current prices.

Aroway believes it has another two wells that can be drilled at Kirkpatrick Lake.

Property 3 – Peace River Arch/Worsley Non-Operated

The Worsley Property is located in northwest Alberta, Canada, north of the city of Grand Prairie, Alberta. Aroway owns between 18.2% and 50% working interest in fifteen gas wells and seventeen oil wells.

Most of the gas wells are shut-in due to low gas prices. Currently eight wells are producing of which 7 are oil wells and one is a gas well. The majority of the remaining shut-in oil wells require recompletions in the shallower zones.

Presently, due to the low gas price and uneconomic netbacks, the Worsley property is only producing somewhere around 40 boe/day.

This is a very large block of land of which Aroway owns 50%. There is potential on this property for several resource plays, but for now Aroway has decided to focus on its 100% owned and operated properties. The Worsely property won’t be playing an important role for Aroway in the near or likely even mid-term.

Once cash flow gets ramped up on the controlled properties it is possible that Aroway could start allocating more capital back here. It is also possible that this asset could be monetized.

Property 4 – Kerrobert Saskatchewan

This is Aroway’s newest property and it could very well be the key asset for the company’s future.

The first piece of this Kerrobert property was acquired in September 2013 when Aroway acquired from a private company a 100% interest in 5,760 acres in exchange for a 12% gross overriding royalty.

The second piece of Kerrobert was added in January 2014 when Aroway reached a deal with a major independent producer (believed to be Devon Energy) to acquire 21 sections of land.

What management believes it has here is something very similar to a property producing 2,500 barrels per day directly to the south.

Aroway’s CEO has been interviewed subsequent to the purchase and has indicated that he believes that the property should be able to support production of up to 2,500 barrels per day. That is more than three times current corporate production.

After the current seismic is done Aroway expects that it will drill its first Kerrobert well in June or July, after spring break-up.

It is important to note that although Aroway is clearly very bullish on this property, it is still exploratory in nature.

Aroway Energy - Balance Sheet / Finances

I’ve learned the hard way that the oil and gas game is an unforgiving business. That is especially true for a small company where every single well is extremely important.

What I’m getting at is that I’m not interested in messing around with junior oil and gas companies that have weak balance sheets.

Aroway is currently sitting with roughly $1.4 million of debt which is well down from the $4.7 million of debt it had after its West Hazel acquisition.

Monthly cash flow is currently $700,000 to $800,000 per month (once the West Hazel water disposal work is complete) which means the Aroway’s debt to cash flow ratio is extremely conservative.

The plan for Aroway is to live within cash flow when it comes to capital spending in 2014 and beyond. With decline rates (company estimates) of roughly 18% at West Hazel and 15% at Kirkpatrick Lake, Aroway looks to be well positioned to be able to grow through internally generated cash flow.

Aroway Energy - Valuation

Current production for Aroway is 300 barrels per day. That is with the West Hazel production shut in pending completion of the water disposal work. Once that work is done production should be up to at least 750 barrels per day.

At the current share price, with 750 barrels per day of production Aroway is trading at $27,000 per flowing barrel. That is very cheap for an oil producer (Aroway is over 90% oil).

But the flowing barrel metric can be deceiving. What really matters at the end of the day is how much cash flow is getting into the corporate bank account.

On an enterprise value to cash flow metric Aroway also looks very inexpensive. With the current cash flow run rate of $750,000 per month Aroway is trading at only 2.2 times enterprise value to cash flow.

At this valuation the market is clearly not factoring in ANY future growth for this company.

Aroway could grow production by drilling additional wells at West Hazel (six wells remaining) and Kirkpatrick Lake (two wells remaining), but it appears that Kerrobert is going to be the focus.

Aroway has indicated that it thinks that Kerrobert could be producing 2,500 barrels at some point in 2016, assuming its exploratory drilling is successful.

If that is true, then the production ramp up for Aroway could look something like this:

Property

Current

2014

2015

2016

Name

Production

Production

Production

Production

Comment

West Hazel

240

450

328

269

18% decline rate

Kirkpatrick

300

300

255

217

15% decline rate

Worsely

40

30

25

20

Kerrobert

0

800

1,500

2,500

580

1,580

2,108

3,006

At a conservative $40,000 per flowing barrel multiple on 3,000 barrels of production Aroway could be worth $120 million, or $1.94 per share.

That would be the ideal scenario which assumes that everything goes smoothly. That is a fairly big assumption given that the Kerrobert property is still unproven.

Even if the company can get halfway to this target while holding debt where it is and avoiding dilution we are likely talking about a double or triple for shareholders from the current price.

The risk is that the Kerrobert property doesn’t perform as expected. If that is the case Aroway is still a company that is generating cash flow with little debt and the ability to sustain and grow that production with Kirkpatrick Lake and West Hazel.

With a valuation of 2.2 times cash flow and very little debt, the downside here appears to be limited. The upside, however, with the Kerrobert property could be a double or triple quite easily if the property performs as management expects.

Aroway Energy - Catalysts

A cheap stock is good. A cheap stock with a catalyst is better.

Aroway should have a couple of catalysts in the coming months that could get the share price moving in the right direction.

The first is the completion of the water disposal work at West Hazel which will immediately bump total company production from 300 to almost 750 barrels of oil per day. That is a big percentage increase in production.

After that it is possible that production at Kirkpatrick Lake could also increase as the second well is currently being brought on very slowly. The company did not want any unexpected problems with this well while West Hazel was off line for the water disposal work.

The following catalyst would be the drilling of an infill West Hazel well which will now be possible with the better water handling capability.

And then the big catalyst would be the drilling of the first Kerrobert exploration well. If that goes well, Aroway could really be off to the races.

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